Module 4
Ethical Reasoning, Decision Making, and Professional Judgment
A. The Basis of Accounting
According to Mintz (1995), “Integrity is a fundamental trait of character that
enables a CPA to withstand client and competitive pressures that might otherwise lead to
the subordination of judgment.” A person of integrity will act out of moral principle and
not expediency. That person will do what is right, even if it means the loss of a job or
client. In accounting, the public interest (i.e., investors and creditors) always must be
placed ahead of one’s own self-interest or the interests of others, including a supervisor
or client. Integrity means that a person acts on principle—a conviction that there is a right
way to act when faced with an ethical dilemma. For example, assume that your tax client
fails to inform you about an amount of earned income for the year, and you confront the
client on this issue. The client tells you not to record it and reminds you that there is no
W-2 or 1099 form to document the earnings.
The client adds that you will not get to audit the company’s financial statements
anymore if you do not adhere to the client’s wishes. Would you decide to “go along to get
along”? If you are a person of integrity, you should not allow the client to dictate how the
tax rules will be applied in the client’s situation. You are the professional and know the
tax regulations best, and you have an ethical obligation to report taxes in accordance with
the law. If you go along with the client and the Internal Revenue Service (IRS)
investigates and sanctions you for failing to follow the IRS Tax Code, then you may
suffer irreparable harm to your reputation. An important point is that a professional must
never let loyalty to a client cloud good judgment and ethical decision making.
Virtually all the world’s great religions contain in their religious texts some
version of the Golden Rule: “Do unto others as you would wish them to do unto you.” In
other words, we should treat others the way we would want to be treated. This is the basic
ethic that guides all religions. If we believe honesty is important, then we should be
honest with others and expect the same in return. One result of this ethic is the concept
that every person shares certain inherent human rights, which will be discussed later in
this chapter. Exhibit 1.1 provides some examples of the universality of the Golden Rule
in world religions provided by the character education organization Teaching Values.
Integrity is the key to carrying out the Golden Rule. A person of integrity acts
with truthfulness, courage, sincerity, and honesty. Integrity means to have the courage to
stand by your principles even in the face of pressure to bow to the demands of others. As
previously mentioned, integrity has particular importance for certified public accountants
(CPAs), who often are pressured by their employers and clients to give in to their
demands. The ethical responsibility of a CPA in these instances is to adhere to the ethics
of the accounting profession and not to subordinate professional judgment to the
judgment of others. Integrity encompasses the whole of the person, and it is the
foundational virtue of the ancient Greek philosophy of virtue.
The origins of Western philosophy trace back to the ancient Greeks, including
Socrates, Plato, and Aristotle. The ancient Greek philosophy of virtue deals with
questions such as: What is the best sort of life for human beings to live? Greek thinkers
saw the attainment of a good life as the telos, the end or goal of human existence. For
most Greek philosophers, the end is eudaimonia, which is usually translated as
“happiness.” However, the Greeks thought that the end goal of happiness meant much
more than just experiencing pleasure or satisfaction. The ultimate goal of happiness was
to attain some objectively good status, the life of excellence. The Greek word for
excellence is arete, the customary translation of which is “virtue.” Thus for the Greeks,
“excellences” or “virtues” were the qualities that made a life admirable or excellent. They
did not restrict their thinking to characteristics we regard as moral virtues, such as
courage, justice, and temperance, but included others we think of as nonmoral, such as
wisdom.
B. Definition of Ethics
The term ethics is derived from the Greek word ethikos, which itself is derived
from the Greek word ethos, meaning “custom” or “character.” Morals are from the Latin
word moralis, meaning “customs,” with the Latin word mores being defined as “manners,
morals, character.” In philosophy, ethical behavior is that which is “good.” The Western
tradition of ethics is sometimes called “moral philosophy.” The field of ethics or moral
philosophy involves developing, defending, and recommending concepts of right and
wrong behavior. These concepts do not change as one’s desires and motivations change.
They are not relative to the situation. They are immutable.
In a general sense, ethics (or moral philosophy) addresses fundamental questions
such as: How should I live my life? That question leads to others, such as: What sort of
person should I strive to be? What values are important? What standards or principles
should I live by? There are various ways to define the concept of ethics. The simplest
may be to say that ethics deals with “right” and “wrong.” However, it is difficult to judge
what may be right or wrong in a particular situation without some frame of reference. In
addition, the ethical standards for a profession, such as accounting, are heavily influenced
by the practices of those in the profession, state laws and board of accountancy rules, and
the expectations of society. Gaa and Thorne define ethics as “the field of inquiry that
concerns the actions of people in situations where these actions have effects on the
welfare of both oneself and others.” We adopt that definition and emphasize that it relies
on ethical reasoning to evaluate the effects of actions on others—the stakeholders.
Ethics and morals relate to “right” and “wrong” conduct. While they are
sometimes used interchangeably, they are different: ethics refer to rules provided by an
external source, such as codes of conduct for a group of professionals (i.e., CPAs), or for
those in a particular organization. Morals refer to an individual’s own principles
regarding right and wrong and may be influenced by a religion or societal mores. Ethics
tend to be more practical than morals, conceived as shared principles promoting fairness
in social and business interactions. For example, a CEO involved in a sex scandal may
involve a moral lapse, while a CEO misappropriating money from a company she is
supposed to lead according to prescribed standards of behavior is an ethical problem.
These terms are close and often used interchangeably, and both influence ethical decision
making. In this text we oftentimes use the terms synonymously while acknowledging
differences do exist
Ethics deal with well-based standards of how people ought to act, does not
describe the way people actually act, and is prescriptive, not descriptive. Ethical people
always strive to make the right decision in all circumstances. They do not rationalize their
actions based on their own perceived self-interests. Ethical decision making entails
following certain well-established norms of behavior. The best way to understand ethics
may be to differentiate it from other concepts.
Values are basic and fundamental beliefs that guide or motivate attitudes or
actions. In accounting, the values of the profession are embedded in its codes of ethics
that guide the actions of accountants and auditors in meeting their professional
responsibilities. Values are concerned with how a person behaves in certain situations
and is predicated on personal beliefs that may or may not be ethical, whereas ethics is
concerned with how a moral person should behave to act in an ethical manner. A person
who values prestige, power, and wealth is likely to act out of self-interest, whereas a
person who values honesty, integrity, and trust will typically act in the best interests of
others. It does not follow, however, that acting in the best interests of others always
precludes acting in one’s own self-interest. Indeed, the Golden Rule prescribes that we
should treat others the way we want to be treated.
When the rules are unclear, an ethical person looks beyond his / her own self-
interest and evaluates the interests of the stakeholders potentially affected by the action or
decision. Ethical decision making requires that a decision maker be willing, at least
sometimes, to take an action that may not be in his / her best interest. This is known as
the “moral point of view.” Sometimes people believe that the ends justify the means. In
ethics it all depends on one’s motives for acting. If one’s goals are good and noble, and
the means we use to achieve them are also good and noble, then the ends do justify the
means. However, if one views the concept as an excuse to achieve one’s goals through
any means necessary, no matter how immoral, illegal, or offensive to others the means
may be, then that person is attempting to justify the wrongdoing by pointing to a good
outcome regardless of ethical considerations such as how one’s actions affect others.
Nothing could be further from the truth. The process you follow to decide on a course of
action is more important than achieving the end goal. If this were not true from a moral
point of view, then we could rationalize all kinds of actions in the name of achieving a
desired goal, even if that goal does harm to others while satisfying our personal needs and
desires.
Ethical relativism is the philosophical view that what is right or wrong and good
or bad is not absolute but variable and relative, depending on the person, circumstances,
or social situation. Ethical relativism holds that morality is relative to the norms of one’s
culture. That is, whether an action is right or wrong depends on the moral norms of the
society in which it is practiced. The same action may be morally right in one society but
be morally wrong in another. For the ethical relativist, there are no universal moral
standards—standards that can be universally applied to all peoples at all times. The only
moral standards against which a society’s practices can be judged are its own. If ethical
relativism is correct, then there can be no common framework for resolving moral
disputes or for reaching agreement on ethical matters among members of different
societies.
Accountants record and report financial truths. Their conduct is regulated by state
boards of accountancy, professional codes of behavior, and moral conventions directed
towards fairness and accountability. However, moral dilemmas and conflicts of interest
inevitably arise when determining how best to present financial information. Betty
Vinson is a case in point. She rationalized that in her circumstances going along with the
improper accounting was justified because if Scott Sullivan, one of the foremost chief
financial officers in the country, thought the accounting was all right, who was she to
question it. After all, ethical judgments can be subjective and, perhaps, this was one of
those situations. Clearly, Vinson suffered from moral blindness because she failed to
consider the negative effects on shareholders and other stakeholders and moral failings of
Sullivan’s position. There was a gap between the person she truly was and how she acted
in the WorldCom fraud brought about by pressures imposed on her by Sullivan.
Situation ethics, a term first coined in 1966 by an Episcopalian priest, Joseph
Fletcher, is a body of ethical thought that takes normative principles—like the virtues,
natural law, and Kant’s categorical imperative that relies on the universality of actions—
and generalizes them so that an agent can “make sense” out of one’s experience when
confronting ethical dilemmas. Unlike ethical relativism that denies universal moral
principles, claiming the moral codes are strictly subjective, situational ethicists recognize
the existence of normative principles but question whether they should be applied as
strict directives (i.e., imperatives) or, instead, as guidelines that agents should use when
determining a course of ethical conduct. In other words, situationists ask: Should these
norms, as generalizations about what is desired, be regarded as intrinsically valid and
universally obliging of all human beings? For situationists, the circumstances
surrounding an ethical dilemma can and should influence an agent’s decision-making
process and may alter an agent’s decision when warranted. Thus, situation ethics holds
that “what in some times and in some places is ethical can be in other times and in other
places unethical.” A problem with a situation ethics perspective is that it can be used to
rationalize actions such as those in the Penn State scandal.
Another danger of situational ethics is it can be used to rationalize cheating.
Cheating in general is at epidemic proportions in society. The 2012 Report Card on the
Ethics of American Youth, conducted by the Josephson Institute of Ethics, found that of
43,000 high school students surveyed, 51 percent admitted to having cheated on a test
during 2012, 55 percent admitted to lying, and 20 percent admitted to stealing. Cheating
in college is prevalent as well. The estimates of number of students engaging in some
form of academic dishonesty at least once ranges from 50 to 70 percent. In 1997,
McCabe and Treviño surveyed 6,000 students in 31 academic institutions and found
contextual factors, such as peer influence, had the most effect on student cheating
behavior. Contextual appropriateness, rather than what is good or right, suggests that
situations alter cases, thus changing the rules and principles that guide behavior
A comprehensive study of 4,950 students at a small southwestern university
identified neutralizing techniques to justify violations of accepted behavior. In the study,
students rationalized their cheating behavior without challenging the norm of honesty.
The most common rationale was denial of responsibility (i.e., circumstances beyond their
control, such as excessive hours worked on a job, made cheating okay in that instance).
Then, they blamed the faculty and testing procedures (i.e., exams that try to trick students
rather than test knowledge). Finally, the students appealed to a higher loyalty by arguing
that it is more important to help a friend than to avoid cheating. One student blamed the
larger society for his cheating: “In America, we’re taught that results aren’t achieved
through beneficial means, but through the easiest means.” The authors concluded that the
use of these techniques of neutralization conveys the message that students recognize and
accept cheating as an undesirable behavior but one that can be excused under certain
circumstances, reflecting a situational ethic.
The Ethics Resource Center conducted a survey of social networkers in 2012 to
determine the extent to which employees use social networking on the job. The survey
points out that social networking is now the norm and that a growing number of
employees spend some of their workday connected to a social network. More than 10
percent are “active social networkers,” defined as those who spend at least 30 percent of
their workday linked up to one or more networks. One concern is whether active social
networkers engage in unethical practices through communications and postings on social
media sites. Survey respondents say they think about risks before posting online and
consider how their employers would react to what they post. But, they do admit to
discussing company information online: 60 percent would comment on their personal
sites about their company if it was in the news; 53 percent share information about work
projects once a week or more; greater than one-third say they often comment, on their
personal sites, about managers, coworkers, and even clients. The survey concludes that
nothing is secret anymore and, unlike in Las Vegas, management must assume that what
happens at work does not stay at work and may become publicly known.
Between 1967 and 1973, Dutch researcher Geert Hofstede conducted one of the
most comprehensive studies of how values in the workplace are influenced by culture.
Using responses to an attitude study of approximately 116,000 IBM employees in 39
countries, Hofstede identified four cultural dimensions that can be used to describe
general similarities and differences in cultures around the world: (1) individualism, (2)
power distance, (3) uncertainty avoidance, and (4) masculinity. In 2001, a fifth
dimension, long-term orientation—initially called Confucian dynamism—was identified.
More recently, a sixth variable was added—indulgence versus restraint—as a result of
Michael Minkov’s analysis of data from the World Values Survey. Exhibit 1.2
summarizes the five dimensions from Hofstede’s work for Japan, the United Kingdom,
and the United States, representing leading industrialized nations; and the so-called BRIC
countries (Brazil, Russia, India, and China), which represent four major emerging
economies.
Other variables have important implications for workplace behavior as well, such
as the Power Distance index (PDI), which focuses on the degree of equality between
people in the country’s society. A high PDI indicates inequalities of wealth and power
have been allowed to grow within society, as has occurred in China and Russia as they
develop economically. Long-term orientation (LTO) versus short-term orientation has
been used to illustrate one of the differences between Asian cultures, such as China and
Japan, and the United States and United Kingdom. In societies like China and Japan, high
LTO scores reflect the values of long-term commitment and respect for tradition, as
opposed to low-LTO countries, such as the United Kingdom and United States, where
change can occur more rapidly. Time can often be a stumbling block for Western-
cultured organizations entering the China market. The length of time it takes to get
business deals done in China can be two or three times that in the West. One final point is
to note that Brazil and India show less variability in their scores than other countries,
perhaps reflecting fewer extremes in cultural dimensions.
C. The Six Pillars of Character
It has been said that ethics is all about how we act when no one is looking. In
other words, ethical people do not do the right thing because someone observing their
actions might judge them otherwise, or because they may be punished as a result of their
actions. Instead, ethical people act as they do because their “inner voice” or conscience
tells them that it is the right thing to do. Assume that you are leaving a shopping mall, get
into your car to drive away, and hit a parked car in the lot on the way out. Let’s also
assume that no one saw you hit the car. What are your options? You could simply drive
away and forget about it, or you can leave a note for the owner of the parked car with
your contact information. What would you do and why? Your actions will reflect the
character of your inner being. According to “virtue ethics,” there are certain ideals, such
as excellence or dedication to the common good, toward which we should strive and
which allow the full development of our humanity. These ideals are discovered through
thoughtful reflection on what we as human beings have the potential to become.
Honesty is the most basic ethical value. It means that we should express the truth
as we know it and without deception. In accounting, the full disclosure principle supports
transparency and requires that the accounting professional disclose all the information
that owners, investors, creditors, and the government need to know to make informed
decisions. To withhold relevant information is dishonest. Transparent information is that
which helps one understand the process followed to reach a decision. In other words it
supports an ethical ends versus means belief.
The integrity of a person is an essential element in trusting that person.
MacIntyre, in his account of Aristotelian virtue, states, “There is at least one virtue
recognized by tradition which cannot be specified except with reference to the wholeness
of a human life—the virtue of integrity or constancy.” A person of integrity takes time for
self-reflection, so that the events, crises, and challenges of everyday living do not
determine the course of that person’s moral life. Such a person is trusted by others
because that person is true to her word. Ultimately, integrity means to act on principle
rather than expediency. If my superior tells me to do something wrong, I will not do it
because it violates the ethical value of honesty. If my superior pressures me to
compromise my values just this one time, I will not agree. I have the courage of my
convictions and am true to the principles of behavior that guide my actions.
The promises that we make to others are relied on by them, and we have a moral
duty to follow through with action. Our ethical obligation for promise keeping includes
avoiding bad-faith excuses and unwise commitments. Imagine that you are asked to
attend a group meeting on Saturday and you agree to do so. That night, though, your best
friend calls and says he has two tickets to the basketball game between the Dallas
Mavericks and San Antonio Spurs. The Spurs are one of the best teams in basketball and
you don’t get this kind of opportunity very often, so you decide to go to the game instead
of the meeting. You’ve broken your promise, and you did it out of self-interest. You
figured, who wouldn’t want to see the Spurs play? What’s worse, you call the group
leader and say that you can’t attend the meeting because you are sick. Now you’ve also
lied. You’ve started the slide down the proverbial ethical slippery slope, and it will be
difficult to climb back to the top.
We all should value loyalty in friendship. After all, you wouldn’t want the friend
who invited you to the basketball game to telephone the group leader later and say that
you went to the game on the day of the group meeting. Loyalty requires that friends not
violate the confidence we place in them. In accounting, loyalty requires that we keep
financial and other information confidential when it deals with our employer and client.
For example, if you are the in-charge accountant on an audit of a client for your CPA
firm-employer and you discover that the client is “cooking the books,” you shouldn’t
telephone the local newspaper and tell the story to a reporter. Instead, you should go to
your supervisor and discuss the matter and, if necessary, go to the partner in charge of the
engagement and tell her. Your ethical obligation is to report what you have observed to
your supervisor and let her take the appropriate action. However, the ethics of the
accounting profession allow for instances whereby informing those above your
supervisor is expected, an act of internal whistleblowing, and in rare circumstances going
outside the organization to report the wrongdoing.
All people should be treated with dignity. We do not have an ethical duty to hold
all people in high esteem, but we should treat everyone with respect, regardless of their
circumstances in life. In today’s slang, we might say that respect means giving a person
“props.” The Golden Rule encompasses respect for others through notions such as
civility, courtesy, decency, dignity, autonomy, tolerance, and acceptance. By age 16,
George Washington had copied by hand 110 Rules of Civility & Decent Behavior in
Company and Conversation. They are based on a set of rules composed by French Jesuits
in 1595. While many of the rules seem out of place in today’s society, Washington’s first
rule is noteworthy: “Every Action done in Company, ought to be with Some Sign of
Respect, to those that are Present.”
A responsible person carefully reflects on alternative courses of action using
ethical principles. A responsible person acts diligently and perseveres in carrying out
moral action. Imagine if you were given the task by your group to interview five CPAs in
public practice about their most difficult ethical dilemma, and you decided to ask one
person, who was a friend of the family, about five dilemmas that person faced in the
practice of public accounting. Now, even if you made an “honest” mistake in interpreting
the requirement, it is clear that you did not exercise the level of care that should be
expected in this instance in carrying out the instructions to interview five different CPAs.
The due care test is whether a “reasonable person” would conclude that you had acted
with the level of care, or diligence, expected in the circumstance. The courts have used
this test for many years to evaluate the actions of professionals.
A person of fairness treats others equally, impartially, and openly. In business, we
might say that the fair allocation of scarce resources requires that those who have earned
the right to a greater share of corporate resources as judged objectively by performance
measures should receive a larger share than those whose performance has not met the
standard. Let’s assume that your instructor told the case study groups at the beginning of
the course that the group with the highest overall numerical average would receive an A,
the group with second highest a B, and so on. At the end of the term, the teacher gave the
group with the second-highest average—90.5—an A and the group with the highest
average—91.2—a B. Perhaps the instructor took subjective factors into account in
deciding on the final grading. You might view the instructor’s action as unfair to the
group with the highest average. It certainly contradicts his original stated policy and is
capricious and unfair, especially if the instructor does not explain his reason for doing
this. As Josephson points out, “Fairness implies adherence to a balanced standard of
justice without relevance to one’s own feelings or inclinations.”
Josephson points out that “citizenship includes civic virtues and duties that
prescribe how we ought to behave as part of a community.” An important part of good
citizenship is to obey the laws, be informed about the issues, volunteer in your
community, and vote in elections. During his presidency, Barack Obama called for
citizens to engage in some kind of public service to benefit society as a whole.
Accounting professionals are part of a community with specific ideals and ethical
standards that govern behavior. These include responsibilities to one another to advance
the profession and not bring discredit on oneself or others. As citizens of a community,
accountants and auditors should strive to enhance the reputation of the accounting
profession.
Universum, the global employer branding and research company, annually
surveys college undergraduate and MBA students. In 2014, it surveyed about 60,000 U.S.
college students from 311 institutions to find out what they were looking for as they enter
the world of work, as well as their views on the attractiveness of specific employers. The
results of the survey reflect a desire to join an organization that respects its people,
provides a supportive environment, recognizes performance, provides development and
leadership opportunities, challenges one intellectually, fosters a work/life 45 balance, and
serves the public good.
Edwards violated virtually every tenet of ethical behavior and destroyed his
reputation. He lied about the affair and attempted to cover it up, including allegations that
he fathered Hunter’s baby. He violated the trust of the public and lied after telling his
family about the affair in 2006. He even had the audacity to run for the Democratic
nomination for president in 2008. One has to wonder what it says about Edwards’s ethics
that he was willing to run for president of the United States while hiding the knowledge
of his affair, without considering what might happen if he had won the Democratic
nomination in 2008, and then the affair became public knowledge during the general
election campaign. His behavior is the ultimate example of ethical blindness and the
pursuit of one’s own self-interests to the detriment of all others. Perhaps the noted
Canadian-American chemist and author Orlando Aloysius Battista (1917–1995), said it
best: “An error doesn’t become a mistake until you refuse to correct it.” In other words,
when you do something wrong, admit it, take responsibility for your actions, accept the
consequences, promise never to do it again, and move on. Unfortunately, most adulterers
like Edwards go to great lengths to cover up their moral failings and don’t admit to them
until they have been caught.
Can there be any doubt that incivility in society is on the rise? Not according to
one of your authors. Mintz opines in his blog about incivility that daily we witness
instances of inconsiderate, “in your face” behavior in communications and other forms of
rudeness. There are many causes of incivility, many of which are social media–driven.
The sometimes anonymous feel of posts on Twitter and other social media sites makes it
relatively easy to use impersonal forms of communication to vent one’s feelings without
the immediate consequences of face-to-face discussions. One inappropriate Twitter rant
begets another and eventually we see a further erosion of ethics in society.
Civility is not peripheral to ethics, dealing merely with manners, proper etiquette,
and politeness. It runs much deeper and requires restraint, respect, and responsible action
both in one’s personal behavior and professional activities. Remember, ethics deals in
broad terms with how we treat others. Two pertinent questions are: Can you be civil and
not entirely ethical? Can you be ethical and not terribly civil? The answer to the first is a
qualified “yes.” You can be well behaved and gracious to others but still be motivated by
non-ethical values such as greed. The problem is you may wind up using others to
advance your self-interests. The answer to the second is “no.” Treating others badly and
with disrespect means you have not committed to act in accordance with the pillars of
character.
D. Modern Moral Philosophies
The ancient Greeks believed that reason and thought precede the choice of action
and that we deliberate about things we can influence with our decisions. In making
decisions, most people want to follow laws and rules. However, rules are not always
clear, and laws may not cover every situation. Therefore, it is the ethical foundation that
we develop and nurture that will determine how we react to unstructured situations that
challenge our sense of right and wrong. In the end, we need to rely on moral principles to
guide our decision making. However, the ability to reason out ethical conflicts may not
be enough to assure ethical decision making occurs in accounting. This is because while
we believe that we should behave in accordance with core values, we may wind up
deviating from these values that trigger ethical reasoning in accounting because of
internal pressures from supervisors and others in top management. In the end, a self-
interest motive may prevail over making a decision from an ethical perspective, and
unethical behavior may result. This is the moral of the story of Betty Vinson’s role in the
WorldCom fraud. Moreover, even if we know what the right thing to do is, we still may
be unable to act on our beliefs because others in the organization provide reasons and
rationalizations to deviate from those beliefs and may establish barriers to ethical action.
This occurred in the WorldCom fraud when Scott Sullivan, the CFO, attempted to divert
Cynthia Cooper from her goal to reveal the accounting fraud.
Adam Smith’s seminal work, An Inquiry Into the Nature and Causes of the
Wealth of Nations (1776), outlined the basis for free-market capitalism. Capitalism
laissez-faire philosophies, such as minimizing the role of government intervention and
taxation in the free markets, and the idea that an “invisible hand” guides supply and
demand are key elements of his political philosophy. These ideas reflect the concept that
each person, by looking out for his or her self-interest, inadvertently helps to create the
best outcome for all. “It is not from the benevolence of the butcher, the brewer, or the
baker, that we can expect our dinner, but from their regard to their own interest,” Smith
wrote. Even before Smith wrote The Wealth of Nations he produced a treatise on moral
philosophy. The Theory of Moral Sentiments (1759) makes the case that business should
be guided by the morals of good people. Smith sets forth a theory of how we come to be
moral, of how morality functions on both individual and societal levels, and of what
forces are likely to corrupt our sense of morality, which is derived from our capacity to
sympathize directly and indirectly with other people. This occurs by feeling what others
actually feel in their circumstances. We are able to achieve this moral perspective
because of our consciences, which allow us to envision our own actions just as a
disinterested observer might.
Recall that telos is the Greek word for “end” or “purpose.” In teleology, an act is
considered morally right or acceptable if it produces some desired result such as pleasure,
the realization of self-interest, fame, utility, wealth, and so on. Teleologists assess the
moral worth of behavior by looking at its consequences, and thus moral philosophers
often refer to these theories as consequentialism. Two important teleological philosophies
that typically guide decision making in individual business decisions are egoism and
utilitarianism.
Egoism defines right or acceptable behavior in terms of its consequences for the
individual. Egoists believe that they should make decisions that maximize their own self-
interest, which is defined differently by each individual. In other words, the individual
should “[d]o the act that promotes the greatest good for oneself.” Many believe that
egoistic people and companies are inherently unethical, are short-term-oriented, and will
take advantage of others to achieve their goals. Our laissez-faire economic system
enables the selfish pursuit of individual profit, so a regulated marketplace is essential to
protect the interests of those affected by individual (and corporate) decision making.
The junior auditor faces a challenge to integrity in this instance. The client is
attempting to circumvent GAAP. The ethical obligation of the staff auditor is not to
subordinate judgment to others’ judgment, including that of top management of the firm.
If you are an egoist, you might conclude that it is in your best interests to go along with
the firm’s position, to support the client’s presumed interests. After all, you do not want
to lose your job. An enlightened egoist would consider the interests of others, including
the investors and creditors, but still might reason that it is in her long-run interests to go
along with the firm’s position to support the client because she may not advance within
the firm unless she is perceived to be a “team player.”
Utilitarians follow a relatively straightforward method for deciding the morally
correct course of action for any particular situation. First, they identify the various
courses of action that they could perform. Second, they determine the utility of the
consequences of all possible alternatives and then select the one that results in the
greatest net benefit. In other words, they identify all the foreseeable benefits and harms
(consequences) that could result from each course of action for those affected by the
action, and then choose the course of action that provides the greatest benefits after the
costs have been taken into account. Given its emphasis on evaluating the benefits and
harms of alternatives on stakeholders, utilitarianism requires that people look beyond
self-interest to consider impartially the interest of all persons affected by their actions.
The utilitarian theory was first formulated in the eighteenth century by the English
writer Jeremy Bentham (1748–1832) and later refined by John Stuart Mill (1806–1873).
Bentham sought an objective basis that would provide a publicly acceptable norm for
determining what kinds of laws England should enact. He believed that the most
promising way to reach an agreement was to choose the policy that would bring about the
greatest net benefits to society once the harms had been taken into account. His motto
became “the greatest good for the greatest number.” Over the years, the principle of
utilitarianism has been expanded and refined so that today there are many different
variations of the principle. Modern utilitarians often describe benefits and harms in terms
of satisfaction of personal preferences or in purely economic terms of monetary benefits
over monetary costs.
While utilitarianism is a very popular ethical theory, there are some difficulties in
relying on it as a sole method for moral decision making because the utilitarian
calculation requires that we assign values to the benefits and harms resulting from our
actions. But it is often difficult, if not impossible, to measure and compare the values of
certain benefits and costs. Let’s go back to our receivables example. It would be difficult
to quantify the possible effects of going along with the client. How can a utilitarian
measure the costs to the company of possibly having to write off a potential bad debt
after the fact, including possible higher interest rates to borrow money in the future
because of a decline in liquidity? What is the cost to one’s reputation for failing to
disclose an event at a point in time that might have affected the analysis of financial
results? On the other hand, how can we measure the benefits to the company of not
recording the allowance? Does it mean the stock price will rise and, if so, by how much?
The term deontology is derived from the Greek word deon, meaning “duty.”
Deontology refers to moral philosophies that focus on the rights of individuals and on the
intentions associated with a particular behavior, rather than on its consequences.
Deontologists believe that moral norms establish the basis for action. Deontology differs
from rule-utilitarianism in that the moral norms (or rules) are based on reason, not
outcomes. Fundamental to deontological theory is the idea that equal respect must be
given to all persons. In other words, individuals have certain inherent rights and I, as the
decision maker, have a duty (obligation, commitment, or responsibility) to respect those
rights. Philosophers claim that rights and duties are correlative. That is, my rights
establish your duties and my duties correspond to the rights of others. The deontological
tradition focuses on duties, which can be thought of as establishing the ethical limits of
my behavior. From my perspective, duties are what I owe to others. Other people have
certain claims on my behavior; in other words, they have certain rights against me.
A right is a justified claim on others. For example, if I have a right to freedom,
then I have a justified claim to be left alone by others. Turned around, I can say that
others have a duty or responsibility to leave me alone. In accounting, because investors
and creditors have a right to accurate and complete financial information, I have the duty
to ensure that the financial statements “present fairly” the financial position, results of
operations, and changes in cash flows. Formulations of rights theories first appeared in
the seventeenth century in writings of Thomas Hobbes and John Locke. One of the most
important and influential interpretations of moral rights is based on the work of
Immanuel Kant (1724–1804), an eighteenth-century philosopher. Kant maintained that
each of us has a worth or dignity that must be respected. This dignity makes it wrong for
others to abuse us or to use us against our will. Kant expressed this idea as a moral
principle: Humanity must always be treated as an end, not merely as a means. To treat a
person as a mere means is to use her to advance one’s own interest. But to treat a person
as an end is to respect that person’s dignity by allowing each the freedom to choose for
himself.
Sometimes the rights of individuals will come into conflict, and one has to decide
which right has priority. There is no clear way to resolve conflicts between rights and the
corresponding moral duties to respect those rights. One of the most widely discussed
cases of this kind is taken from William Styron’s novel Sophie’s Choice. Sophie and her
two children are at a Nazi concentration camp. A guard confronts Sophie and tells her
that one of her children will be allowed to live and one will be killed. Sophie must decide
which child will be killed. She can prevent the death of either of her children, but only by
condemning the other to be killed. The guard makes the situation even more painful for
Sophie by telling her that if she chooses neither, then both will be killed. With this added
factor, Sophie has a morally compelling reason to choose one of her children. But for
each child, Sophie has an equally strong reason to save him or her. Thus, the same moral
precept gives rise to conflicting obligations.
Justice is usually associated with issues of rights, fairness, and equality. A just act
respects your rights and treats you fairly. Justice means giving each person what she or he
deserves. Justice and fairness are closely related terms that are often used
interchangeably, although differences do exist. While justice usually has been used with
reference to a standard of rightness, fairness often has been used with regard to an ability
to judge without reference to one’s feelings or interests.
The most fundamental principle of justice, defined by Aristotle more than 2,000
years ago, is that “equals should be treated equally and unequals unequally.” In other
words, individuals should be treated the same unless they differ in ways that are relevant
to the situation in which they are involved. The problem with this interpretation is in
determining which criteria are morally relevant to distinguish between those who are
equal and those who are not. It can be a difficult theory to apply in business if, for
example, a CEO of a company decides to allocate a larger share of the resources than is
warranted (justified), based on the results of operations, to one product line over another
to promote that operation because it is judged to have more long-term expansion and
income potential. If I am the manager in charge of the operation getting fewer resources
but producing equal or better results, then I may believe that my operation has been (I
have been) treated unfairly. On the other hand, it could be said that the other manager
deserves to receive a larger share of the resources because of the long-term potential of
that other product line. That is, the product lines are not equal; the former deserves more
resources because of its greater upside potential.
Virtue considerations apply both to the decision maker and to the act under
consideration by that party. This is one of the differences between virtue theory and the
other moral philosophies that focus on the act. To make an ethical decision, I must
internalize the traits of character that make me an ethical (virtuous) person, such as the
Six Pillars of Character. This philosophy is called virtue ethics, and it posits that what is
moral in a given situation is not only what conventional morality or moral rules require
but also what a well-intentioned person with a “good” moral character would deem
appropriate.
MacIntyre relates virtues to the internal rewards of a practice (i.e., the accounting
profession). He differentiates between the external rewards of a practice (such as money,
fame, and power) and the internal rewards, which relate to the intrinsic value of a
particular practice. MacIntyre points out that every practice requires a certain kind of
relationship between those who participate in it. The virtues are the standards of
excellence (i.e., AICPA Code principles) that characterize relationships within the
practice. To enter into a practice is to accept the authority of those standards, obedience
to the rules, and commitment to achieve the internal rewards. Some of the virtues that
MacIntyre identifies are truthfulness, trust, justice, courage, and honesty.
We realize that for students, it may be difficult to internalize the concept that,
when forced into a corner by one’s supervisor to go along with financial wrongdoing, you
should stand up for what you know to be right, even if it means losing your job.
However, ask yourself the following questions: Do I even want to work for an
organization that does not value my professional opinion? If I go along with it this time,
might the same demand be made at a later date? Will I begin to slide down that ethical
slippery slope where there is no turning back? How much is my reputation for honesty
and integrity worth? Would I be proud if others found out what I did (or didn’t do)? To
quote the noted Swiss psychologist and psychiatrist, Carl Jung: “You are what you do,
not what you say you’ll do.”
E. The Public Interest in Accounting
Following the disclosure of numerous accounting scandals in the early 2000s at
companies such as Enron and WorldCom, the accounting profession, professional bodies,
and regulatory agencies turned their attention to examining how to rebuild the public trust
and confidence in financial reporting. Stuebs and Wilkinson point out that restoring the
accounting profession’s public interest focus is a crucial first step in recapturing the
public trust and securing the profession’s future. Copeland believes that in order to regain
the trust and respect the profession enjoyed prior to the scandals, the profession must
rebuild its reputation on its historical foundation of ethics and integrity.
Typically, licensed CPAs work for public accounting firms, and in business,
government, and education. It is important to note that state board rules and statutory
regulations always supersede rules of professional associations, such as the AICPA, so
that when the rules conflict a licensed CPA should follow the state board rules. A good
example is when a licensed CPA has possession of client records while performing
professional services. Under Rule 501.76 of the Texas State Board of Public
Accountancy, a licensee must not withhold client records, including workpapers that
constitute client records, once a demand has been made for them regardless of whether
fees due to the licensee are outstanding for services already provided. However, under
Rule 501 (Section 1.400.200) of the AICPA Code of Professional Conduct (AICPA
Code), members of the AICPA can withhold member work product if there are fees due
for the specific work product. In this instance, the more restrictive requirement of the
Texas State Board must be followed.
Professions are defined by the knowledge, skills, attitudes, behaviors, and ethics
of those in the (accounting) profession. Regulation of a profession is a specific response
to the need for certain standards to be met by the members of the profession. The
accounting profession provides an important public service through audits and other
assurance services and those who choose to join the community pledge to act in the
public interest. According to IFAC Policy Position Statement 1, a number of reasons
exist why regulation might be necessary to ensure that appropriate quality is provided in
the market for professional accounting services. These include compliance with ethics,
technical, and professional standards and the need to represent the interests of users of
those services (i.e., investors and creditors).
The due care standard also relates to the scope and nature of services performed
by a CPA. The latter requires that CPAs practice in firms that have in place internal
quality control procedures to ensure that services are competently delivered and
adequately supervised and that such services are consistent with one’s role as a
professional. Also, CPAs should determine, in their individual judgments, whether the
scope and nature of other services provided to an audit client would create a conflict of
interest in performing an audit for that client. A high-quality audit features the exercise of
professional judgment by the auditor and professional skepticism throughout the planning
and performance of the audit. Professional skepticism is an essential attitude that
enhances the auditor’s ability to identify and respond to conditions that may indicate
possible misstatement of the financial statements. Professional judgment is a critical
component of ethical behavior in accounting. The qualities of behavior that enable
professional judgment come not only from the profession’s codes of conduct, but also the
virtues and ability to reason through ethical conflicts using ethical reasoning methods.
Traits of character such as honesty, integrity, and trustworthiness enable a person
to act with virtue and apply the moral point of view. Kurt Baier, a well-known moral
philosopher, discusses the moral point of view as being one that emphasizes practical
reason and rational choice. To act ethically means to incorporate ethical values into
decision making and to reflect on the rightness or wrongness of alternative courses of
action. The core values of integrity, objectivity, and independence; attitudes for
exercising professional skepticism; and a framework for ethical reasoning all underlie
virtue-based decision making in accounting.
Many internal accountants, such as controllers and CFOs, are CPAs and members
of the IMA. The IMA’s Statement of Ethical Professional Practice is presented in Exhibit
1.5. Other than independence, which is a specific ethical requirement of an external audit,
the standards of the IMA are similar to the Principles of Professional Conduct in the
AICPA Code. Most important, read through the “Resolution of Ethical Conflict” section,
which defines the steps to be taken by members when they are pressured to go along with
financial statement improprieties. Specific steps to be taken include discussing matters of
concern with the highest levels of the organization, including the audit committee.
F. Kohlberg and the Cognitive Development Approach
Cognitive development refers to the thought process followed in one’s moral
development. An individual’s ability to make reasoned judgments about moral matters
develops in stages. The psychologist Lawrence Kohlberg concluded, on the basis of 20
years of research, that people develop from childhood to adulthood through a sequential
and hierarchical series of cognitive stages that characterize the way they think about
ethical dilemmas. Moral reasoning processes become more complex and sophisticated
with development. Higher stages rely upon cognitive operations that are not available to
individuals at lower stages, and higher stages are thought to be “morally better” because
they are consistent with philosophical theories of justice and rights. Kohlberg’s views on
ethical development are helpful in understanding how individuals may internalize moral
standards and, as they become more sophisticated in their use, apply them more critically
to resolve ethical conflicts.
In Europe, a woman was near death from a rare type of cancer. There was one
drug that the doctors thought might save her. It was a form of radium that a druggist in
the same town had recently discovered. The drug was expensive to make, but the druggist
was charging 10 times what the drug cost him to make: It cost $200 for the radium, and
he charged $2,000 for a small dose of the drug. The sick woman’s husband, Heinz, went
to everyone he knew to borrow the money, but he could get together only about $1,000—
half the cost. He told the druggist that his wife was dying and asked him to sell it cheaper
or let him pay later. But the druggist said, “No, I discovered the drug and I’m going to
make money from it.” Heinz got desperate and broke into the man’s store to steal the
drug for his wife.
William Crain addresses whether different cultures socialize their children
differently, thereby teaching them different moral beliefs. He points out that Kohlberg’s
response has been that different cultures do teach different beliefs, but that his stages
refer not to specific beliefs, but to underlying modes of reasoning. We might assume,
then, that in a collectivist society, blowing the whistle on a member of a work group
would be considered improper because of the “family” orientation (Stage 3), while in a
more individualistic one, it is considered acceptable because it is in the best interests of
society (Stage 4). Thus, individuals in different cultures at the same stage-sequence might
hold different beliefs about the appropriateness of whistleblowing but still reason the
same because, from a fairness perspective, it is the right way to behave.
The role of an accountant is to tell a story—to make an account—of a series of
business activities. This story can be told from a variety of perspectives (i.e., employer or
client) and can therefore result in many accounts. It is the role of the accountant to
determine the perspective that will fairly present the information in accordance with laws
and accounting standards, but they contain options and ambiguities. A higher level of
understanding is required to deal with these different perspectives, the options and
ambiguities that exist within the standards, and the uncertainties of business life. This
higher level of understanding is encapsulated in the postconventional level of reasoning.
Within the cognitive-developmental paradigm the most distinguishing
characteristic of morality is the human capacity to reason. Moral judgment has long been
regarded as the single most influential factor—and the only truly moral determinant—of
a person’s moral behavior. By definition, morality requires that a person’s actions be
rational, motivated by purpose or intent, and carried out with autonomous free will.
Kohlberg maintained that it is as a result of development in moral reasoning that one
becomes truly a moral person, in both mind and deed. Kohlberg’s work is not without its
critics. Some philosophers complain it draws too heavily from Rawls’s Theory of Justice
and makes deontological ethics superior to other ethical perspectives. They note that the
theory applies more to societal issues than to individual ethical decisions. A number of
psychologists have challenged the notion that people go through “rigid” stages of moral
reasoning, arguing instead that they can engage in many ways of thinking about a
problem, regardless of their age.
G. Rest’s Four-Component Model of Ethical Decision Making
The first step in moral behavior requires that the individual interpret the situation
as moral. Absent the ability to recognize that one’s actions affect the welfare of others, it
would be virtually impossible to make the most ethical decision when faced with a moral
dilemma. A good example of failing to spot the ethical issues is Dennis Kozlowski, the
former CEO of Tyco International. On June 17, 2005, Kozlowski was convicted of
crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the
purchase of art for his Manhattan apartment of $14.725 million, and the payment by Tyco
of a $20 million investment banking fee to Frank Walsh, a former Tyco director. He also
had Tyco pay the $30 million for his apartment, which included $6,000 shower curtains
and $15,000 “dog umbrella stands,” not to mention charging the company one-half of the
$2 million, 40th birthday party for his wife held on the Italian island of Sardinia under the
guise of having a board of directors meeting.
An individual’s ethical cognition of what “ideally” ought to be done to resolve an
ethical dilemma is called prescriptive reasoning. The outcome of one’s prescriptive
reasoning is his ethical judgment of the ideal solution to an ethical dilemma. Generally,
an individual’s prescriptive reasoning reflects his cognitive understanding of an ethical
situation as measured by his level of moral development. Once a person is aware of
possible lines of action and how people would be affected by the alternatives, a process
aided by the philosophical reasoning methods, a judgment must be made about which
course of action is more morally justifiable (which alternative is just or right).
After concluding what course of action is best, decision makers must be focused
on taking the moral action and follow through with ethical decision making. Moral values
may conflict with other values. Moral motivation reflects an individual’s willingness to
place ethical values (e.g., honesty, integrity, trustworthiness, caring, and empathy) ahead
of nonethical values (e.g., wealth, power, and fame) that relate to self-interest. An
individual’s ethical motivation influences her intention to comply or not comply with her
ethical judgment in the resolution of an ethical dilemma. Sometimes individuals want to
do the right thing but are overwhelmed by countervailing pressures that may overpower
their ethical intentions because of perceived personal costs. The loss of a job or a client
can be motivating factors that compromise integrity and block ethical action.
Individuals do not always behave in accordance with their ethical intention. An
individual’s intention to act ethically and her ethical actions may not be aligned because
of a lack of ethical character. Individuals with strong ethical character will be more likely
to carry out their ethical intentions with ethical action than individuals with a weak
ethical character because they are better able to withstand any pressures (i.e., have
courage and maintain integrity to do otherwise). Once a moral person has considered the
ethics of the alternatives, she must construct an appropriate plan of action, avoid
distractions, and maintain the courage to continue. Executing a plan of action takes
character. Moral agents have to overcome indifference and opposition, resist distractions,
cope with fatigue, and develop tactics and strategies for reaching their goals. Johnson
points out that this helps to explain why there is only a moderate correlation between
moral judgment and moral behavior. Many times deciding does not lead to doing.
The lack of research on the characteristics of a moral issue prompted Thomas
Jones to develop the moral intensity model. He argued that the characteristics of the
moral issue—what he collectively termed moral intensity—influence ethical decision
making. Jones’s model links moral intensity to Rest’s Four-Component Model. The six
dimensions are briefly explained below. Magnitude of Consequences refers to the degree
to which an individual may be harmed or benefited by the decision maker’s action. A
greater degree of harm or benefit results in an increase in moral intensity. Temporal
Immediacy refers to the length of time between the action and its consequences. An
action with immediate negative consequences will cause a greater increase in moral
intensity than an action for which the consequences are delayed.
One question that arises from Rest’s model is how to align ethical behavior with
ethical intent. The answer is through the exercise of virtue, according to a study
conducted by Libby and Thorne. The authors point out that audit failures at companies
such as Enron and WorldCom demonstrate that the rules in accounting cannot replace
auditors’ professional judgment. Transactions (i.e., special-purpose entities at Enron) can
be structured around rules, and rules cannot be made to fit every situation. The rules may
be unclear or nonexistent, in which case professional judgment is necessary for decisions
to be made in accordance with the values of the profession as embodied in its codes of
conduct. Professional judgment requires not only technical competence, but also depends
on auditors’ ethics and virtues.
H. Ethical Decision-Making Models
In commenting on the method, Velasquez points out that it does not provide an
automatic solution to moral problems. It is not meant to. The method is merely meant to
help identify most of the important ethical considerations. In the end, we must deliberate
on moral issues for ourselves, keeping a careful eye on both the facts and on the ethical
considerations involved. Virtue is not specifically recognized in the philosophical model,
although it is implied by the considerations. It would be difficult to answer these
questions in a morally appropriate way without being an honest, trustworthy person in
evaluating these considerations and willing to act out of integrity in deciding on the
preferred course of action.
Johnson evaluates Kidder’s approach to ethical decision making by pointing out it
seems to cover all the bases, beginning with defining the issue all the way through to
learning from the situation in the aftermath of the decision. He recognizes that some
decisions involve deciding between two “goods” and leaves the door open for creative
solutions. Making a choice is an act of courage, as Kidder points out, and we can apply
lessons learned in one dilemma to future problems.
We believe that a decision-making process in accounting helps to organize one’s
thoughts about the ethical issues that accounting professionals face and can serve as a
basis for analysis in many of the cases in this book. The integrated model explained
below draws on Rest’s Model and Kidder’s Checkpoints to provide a basis for ethical
decision making when accounting issues create ethical dilemmas. Consideration is given
to moral intensity and how intellectual instrumental virtues enable ethical action to occur.
I. Behavioral Ethics
The field of behavioral ethics emphasizes the need to consider how individuals
actually make decisions, rather than how they would make decisions in an ideal world.
Research in behavioral ethics reveals that our minds have two distinct modes of decision
making— “System 1” and “System 2” thinking. Daniel Kahneman, the Nobel Prize–
winning behavioral economist, points out that System 1 thinking is our intuitive system
of processing information: fast, automatic, effortless, and emotional decision processes;
on the other hand, System 2 thinking is slower, conscious, effortful, explicit, and a more
reasoned decision process. For example, System 1 thinking is detecting that one object is
more distant than another, while an example of System 2 thinking is parking in a narrow
space.
Cognitive dissonance suggests that we have an inner drive to hold all our attitudes
and beliefs in harmony and avoid disharmony. When there is inconsistency between
attitudes or behaviors (dissonance), something must change to eliminate the dissonance.
Festinger posits that dissonance can be reduced in one of three ways: (1) change one or
more of the attitudes, behavior, or beliefs so as to make the relationship between the two
elements a consonant one; (2) acquire new information that outweighs the dissonant
beliefs; or (3) reduce the importance of the cognitions (beliefs, attitudes).
Bazerman and Gino ask: What makes even good people cross ethical boundaries?
Wittmer asks: Do individuals in organizations always act and behave consistently with
what they know or believe to be the right thing to do? The behavioral approach to ethics
leads to understanding and explaining moral and immoral behavior in systematic ways. In
reality, whether behaviors are viewed legally or ethically, we hold individuals
accountable for their behaviors and choices, at least in part because they should have
known better. Even if we agree on what someone should ethically do in a given situation,
our judgment is often clouded by other factors that cause us to act against our intuition of
what good sense dictates.
J. Professional Judgment in Accounting
Professional judgment is influenced by personal behavioral traits (i.e., attitudes
and ethical values) as well as one’s knowledge of the accounting and auditing issues in
question. Theoretical models of ethical decision making, such as that of Hunt and Vitell,
include personal values in their theory as one of several personal characteristics that
potentially influence all ethical decision processes.
Judgment occurs in a setting of uncertainty, risk, and often conflicts of interest.
We can see the link between judgment and decision making not only in Rest’s model but
the Integrated Model of Ethical Decision Making described in Chapter 2. The evaluation
of alternatives links to ethical intent, which leads to ethical action. Professional judgment
follows a similar path with pressures along the way imposed by one’s supervisor, top
management, or CPA firm management that might lead to compromising judgment.
Each of us have our own biases that may cloud decision making and alter our
final choices. We may be easy going and avoid conflicts at all costs, which would not
make for a very good auditor, who needs to have a questioning mind and be willing to
critically assess audit data. We also need to be deliberative about our thought processes
and consider both the why and the how we make decisions. Recall our discussion in
Chapter 2 about System 1 and System 2 thinking. System 1 thinking is fast, automatic,
effortless, and difficult to control or modify. It is instinctive whereas System 2 is slower,
effortful, and a more deliberative process. The auditor in our previous example may act
quickly and dismiss any attempt to engage in a thoughtful process that critically analyzes
the reasons for and against examining additional documents to gather reliable evidence
about the supportability of the expenditures.
Glover and Prawitt authored the monograph Enhancing Auditor Professional
Skepticism for the Standards Working Group of the Global Policy Committee
(comprising BDO, Deloitte, Ernst & Young, Grant Thornton, KPMG, and
PricewaterhouseCoopers). The purpose of the monograph is to develop a common
understanding of professional skepticism, how it should be applied, the threats to
professional skepticism and the safeguards that may be cost-effective. It begins by
defining professional skepticism by linking back to the Greek word skeptikos, meaning
“inquiring or reflective.” To inquire is “to seek information by questioning.” The
characteristics commonly associated with being a skeptic include questioning and careful
observation, probing reflection, looking beyond the obvious, and suspension of belief.
K. The Public Interest in Accounting
Professional judgment is what makes an accountant a professional and it underlies
the fundamental obligation to protect the public interest. The profession’s codes of ethics
call for independent judgments and to not subordinate professional judgment to a
supervisor or client. Professional accountants make judgments about specific accounting
treatments, such as fair value measurement and revenue recognition, and in determining
the nature, timing, and scope of necessary audit procedures. Professional judgment is
essential to evaluating the risks of material misstatements in the financial statements.
When professional judgment is compromised by taking shortcuts or allowing biases and
pressures imposed by others to taint decision making, the public loses trust in the
accounting profession.
The growth in consulting services raises questions about any conflict of interest
that might arise between consulting and auditing. For example, when examining activities
of the client that result from the firm’s consulting services, a reasonable person may
conclude that the auditor could not be independent of the client in performing audit
services because of the consulting relationship. Just imagine if the auditor determined
that the consulting work done was deficient or led to financial problems for the client.
Can the auditor still be independent when conducting the audit? The fact is it does not
matter whether the auditor is independent because as long as the appearance of
independence has been tainted by the consulting relationship, the independence standard
would be compromised.
In examining whether professionalism and commercialism can coexist in CPA
firms, Love points out that the profession will lose its raison d’etre if the public believes
that CPAs are not independent due to the type of, or amount of fees received for, advisory
services performed for clients upon which they render any assurance opinion. We would
like to think that the profession learned its lesson from Enron where Andersen received
$27 million for tax and consulting services and $25 million for auditing. Unfortunately,
this may be an instance of going “back to the future” as the profession has been
investigated over and over again since 1977 for certain practices that threaten the public
interest, including providing consulting services for audit clients.
L. The Auditors
The auditing profession in the United States has come under periodic scrutiny
from Congress during the past 40 years. The questions that are consistently asked are:
Where were the auditors? Why didn’t auditing firms detect and report the many frauds
that occurred during this time period? Was it a matter of bending to the wishes of the
client that hires (and can fire) the firm, and pays its fee? Were these failures due to
inadequate and sometimes sloppy audits by firms that may have been trying to cut
corners because they lowballed their audit fees to lure clients, with the hope of gaining
lucrative tax advice and consulting fees down the road? In the case of Andersen’s
treatment of Enron, it seems all of the factors were present, as well as the cozy
relationship that the auditor had with Enron that influenced the firm’s ability to be
independent in making decisions regarding the audits.
As CPA firms have become global entities, the profession’s concern about ethics
and regulation has grown. In 1977, a major study examined the relationship between
auditors and clients and the provision of nonauditing services for those clients. The
Metcalf (Moss) Report was the first real investigation of the accounting profession since
the 1930s. An investigation was conducted between 1975 and 1977 by Senator Lee
Metcalf (D-MT) and, on the House side, Representative John Moss (D-CA). The Metcalf
Report issued four recommendations, two of which are described here. The report did not
lead to any new legislation at the time, although in the aftermath of the frauds at Enron
and WorldCom, changes were made to enhance audits and financial reporting.
Representative Ron Wyden (D-OR) had introduced a bill in May 1986 to hold the
accounting profession responsible for the detection of fraud in light of the failure at ESM
Government Securities and bank failures in the early 1980s at Continental Illinois
National Bank and Trust and Penn Square Bank. Even though Continental Illinois had
received a $4.5 billion federal bailout, the company ultimately was liquidated by the
Federal Deposit Insurance Corporation (FDIC) just four months after receiving an
unqualified opinion on its audit by Peat Marwick (now KPMG). This was the first time
we heard the refrain in Congress, “Where were the auditors?
The National Commission on Fraudulent Financial Reporting, referred to as the
Treadway Committee after its chair James C. Treadway, was formed in 1985 to study and
report on the factors that can lead to fraudulent financial reporting. The Committee of
Sponsoring Organizations (COSO) of the Treadway Commission was established as a
result of the commission’s work and turned its attention to corporate culture. As
discussed in Chapter 3, COSO emphasizes the need to change corporate culture and
establish the systems necessary to prevent fraudulent financial reporting. It starts with the
tone at the top and relies on a strong system of internal controls built on a foundation of
ethics. Its lasting legacy is the development of an integrated framework for internal
control that serves as the foundation for companies to build effective internal control
systems. The systems are evaluated annually by management and a report prepared, as
required by SOX. Auditors then do their own independent review and issue their own
assessment. The framework was first identified in 1992 and since has been updated with
the most recent version issued in 2013, “The 2013 COSO Framework and SOX
Compliance.”
M. Independence Considerations for Members in Public Practice
On June 1, 2014, the AICPA issued a codification of the principles, rules, and
interpretations and rulings in the AICPA Code of Professional Conduct (Revised Code)
that simplifies the identification of topics that are now contained in designated areas,
whereas a CPA used to have to wade through actual rules, interpretations, and rulings to
be knowledgeable about all aspects of an ethical situation. A major improvement of the
Revised Code is the creation of three sections, one each for members in public practice,
members in business, and other members. This simplifies identifying how the rules apply
to practitioners in the performance of their professional services.
The most significant change is the incorporation of two broad conceptual
frameworks, one for members in public practice and another for CPAs in business. These
conceptual frameworks incorporate a “threats and safeguards” approach and are designed
to assist users in analyzing relationships and circumstances that the code does not
specifically address. A significant improvement is the new section on “Ethical Conflicts”
that arise from obstacles to following the appropriate course of action due to internal or
external pressures and/or conflicts in applying relevant professional standards or legal
standards. The ethical conflicts provision is used in combination with the conceptual
framework to determine whether specific rules of conduct have been violated. The
Revised Code was transitioned in and became fully effective on December 15, 2015.
Section 1.000.010 describes a conceptual framework that applies to members in
public practice and provides a foundation to evaluate whether threats to the CPA’s
compliance with the rules of conduct are at an acceptable level or whether safeguards
should be developed to prevent a violation of the rules. Under the Code, in the absence of
an interpretation of a specific rule of conduct that addresses a particular relationship or
circumstance, a CPA should evaluate whether that relationship or circumstance would
lead a reasonable and informed third party who is aware of the relevant information to
conclude a threat exists to the CPA’s compliance with the rules that is not at an
acceptable level. In some circumstances no safeguards can reduce a threat to an
acceptable level. For example, a CPA cannot subordinate professional judgment to others
without violating the “Integrity and Objectivity” Rule.
N. SEC Position on Auditor Independence
Publicly owned companies have been obligated to follow SEC rules since the
passage of the Securities Act of 1933 and the Securities and Exchange Act of 1934. The
PCAOB has taken some of that responsibility away from the SEC, while at the same time
requiring the SEC to adopt final rules on auditor independence. The SEC approach to
independence emphasizes independence in fact and appearance in three ways: (1)
proscribing certain financial interests and business relationships with the audit client, (2)
restricting the provision of certain nonauditing services to audit clients, and (3) subjecting
all auditor conduct to a general standard of independence. The general standard of
independence is stated as follows: “The Commission will not recognize an accountant as
independent, with respect to an audit client, if the accountant is not, or a reasonable
investor with knowledge of all relevant facts and circumstances would conclude that the
accountant is not, capable of exercising objective and impartial judgment on all issues
encompassed within the accountant’s engagement.”
Over the years, the SEC has brought actions against auditing firms for violating
the independence rules. The cases are instructive and illustrate the failure of the auditing
profession to adhere to both the form and the spirit of the independence rules, and
therefore violate the public trust. All firms become targets of the SEC sooner or later
because of the threats to independence. We have selected one such independence
violation for each of the Big Four.
The SEC found that EY and PeopleSoft had a “symbiotic relationship” engaging
in joint sales and marketing efforts and sharing considerable proprietary and confidential
business information, and that EY partnered with PeopleSoft to accomplish increased
sales and boost consulting revenues for EY. The findings of the SEC indicate that EY and
PeopleSoft acted together to promote the product so that a reasonable investor with
knowledge of all the facts would conclude that EY was closely identified in fact and
appearance with its audit client. Brenda P. Murray, the chief administrative law judge at
the SEC, wrote in her opinion that “Ernst’s day-to-day operations were profit-driven and
ignored considerations of auditor independence.”
O. Rules of Professional Practice
The competence standard for CPAs in business includes a requirement that when
a CPA who is a stockholder, partner, director, officer, or employee of an entity prepares
or submits the entity’s financial statements to third parties, the CPA should clearly
communicate, preferably in writing, the CPA’s relationship to the entity and should not
imply that she is independent of the entity. In addition, if the communication states
affirmatively that the financial statements are presented in conformity with the applicable
financial reporting framework, the CPA should comply with the Accounting Principles
Rule. It is important for CPAs in business to take note of these requirements because
from time to time they may be asked to prepare and submit financial statements to
support a loan request of the employer.
A variety of professional standards establish rules of conduct related to specific
services including Statements on Auditing Standards (SAS), Statements on Standards for
Accounting and Review Services (SSARS), Statements on Standards for Consulting
Services (SSCS), and Statements on Standards for Tax Services (SSTS). The Accounting
Principles Rule obligates CPAs to ensure that the financial statements are prepared in
accordance with GAAP and assess whether any material modifications to those
statements are needed. If a CPA believes a departure from GAAP is justified to avoid
misleading statements due to unusual circumstances, then the CPA can still comply with
the rule by describing the departure; its approximate effects, if practicable; and the
reasons why compliance with the principle would result in a misleading statement.
A confidentiality requirement exists for employees of firms that precludes
disclosing confidential employer information obtained as a result of an employment
relationship, such as discussions with the employer’s vendors, customers, or lenders. An
example where confidential information is generally protected is customer lists, target
clients, costs, and marketing strategies that might afford competitive advantages. Perhaps
the most dangerous situation is when an employee leaves the company, by choice or
force, and decides to use confidential information for personal gain.
Ethics rules apply not only to individual CPAs who are licensed by state boards
but also to accounting firms and certain members of alternative practice structures,
networks, and affiliate firms. The forms of organization used by CPA firms over the
years have changed to recognize the importance of nonattest services to the revenue flow
of firms and competition with non-CPA firms in providing such services. Years ago,
CPAs had to own 100 percent of a firm’s equity interests. Today, most states simply
require a majority ownership in the hands of licensed CPAs.
P. Ethics and Tax Services
Students who graduate from college and take positions with accounting firms
might end up providing tax services for a client at some time in their careers. Tax
services include tax compliance, where much of the service is derived from audited
financial records, tax consulting, tax planning, and tax shelters. The AICPA explicitly
recognizes the tax professional’s dual obligations to the client to act as an advocate and to
foster integrity in the tax system by honestly and fairly administering the tax laws. While
client advocacy is an acceptable standard in tax practice, the tax accountant remains
obligated to act objectively, with integrity, exercise due care, and follow the Statements
on Standards for Tax Services (SSTS) issued by the AICPA. In addition, the CPA must
place the public interest ahead of those of the client and self-interests.
The statement addresses a CPA’s obligation to advise a taxpayer of relevant tax
return disclosure responsibilities and potential penalties. In addition to the AICPA and
IRS tax regulations, various taxing authorities at the federal, state, and local levels may
impose specific reporting and disclosure standards with regard to recommending tax
return positions or preparing or signing a tax return. A CPA should determine and
comply with the standards, if any, that are imposed by the applicable taxing authority
with respect to recommending a tax return position, or preparing or signing a tax return.
If the applicable taxing authority has no written standards in this regard, then the
following standards will apply.
A listed transaction is defined by the IRS as a transaction that is the same as or
substantially similar to one of the types of transactions that the IRS has determined to be
a tax avoidance transaction. Such actions are identified by notice, regulation, or other
form of published guidance as listed transactions. Tax avoidance transactions are
sometimes labeled tax shelters. It is complicated, but basically the term prohibited tax
shelter transaction means listed transactions, transactions with contractual protection, or
confidential transactions.
